Northern District Of California Pares Claims In Putative Class Action Against Videoconferencing Company
On February 16, 2022, Judge James Donato of the Northern District of California granted in part and denied in part a motion to dismiss a putative class action asserting claims under the Securities Exchange Act of 1934 against a videoconferencing company and certain of its executives. In re Zoom Sec. Litig., No. 20-cv-02353-JD (N.D. Cal. Feb. 16, 2022). Plaintiff alleged that the company made misrepresentations concerning the level of encryption on its primary videoconferencing product. The Court held that plaintiff sufficiently alleged falsity, scienter, and loss causation as to the CEO’s challenged statements regarding encryption, but it dismissed claims as to certain other alleged misstatements, and all claims against one executive, for failure to sufficiently allege scienter, while granting leave to amend.
The Court first held that plaintiff adequately alleged that the company misrepresented that its primary videoconferencing product offered “end-to-end encryption,” which plaintiff claimed was inaccurate because the company retained the ability to centrally decrypt and access the communications of its end users. Slip op. at 4. The Court rejected the company’s argument that “end-to-end encryption” can have different meanings, emphasizing that defendants’ statements as alleged in the complaint showed otherwise. Id. at 4-5. In particular, the Court pointed to an alleged statement by the company’s CEO apologizing for “incorrectly suggesting” that its product offered “end-to-end encryption” and recognizing that there was a “discrepancy between the commonly accepted definition … and how we were using it.” Id. at 5.
Regarding scienter, the Court determined that plaintiff adequately alleged scienter with respect to the company’s CEO, and thus with respect to the company. Id. at 5-6. The Court rejected defendants’ argument that the CEO’s apology for the company’s prior “incorrect” use of the term failed to show that he had the same understanding at the time he made the allegedly false statement one year prior. Id. at 5-6. The Court emphasized that, given the CEO’s technical background—including an advanced engineering degree, founding a prior videoconferencing platform, and being named on several encryption-related patents—there was “no factual basis” to believe that the CEO’s understanding of the term in question changed in a relevant way between the time he made the statement and the time he issued the apology. Id. at 6.
The Court also held that loss causation was sufficiently alleged based on alleged corrective disclosures. Id. at 6. The Court noted that stock price declines when a news article allegedly revealed the truth about the company’s encryption technology and again following the CEO’s apology gave the Court “some assurance that the theory has a basis in fact.” Id. at 6-7. The Court rejected defendants’ argument that the truth of the company’s encryption technology had already been previously reported, determining that this was a factual argument that could not be resolved on the pleadings. Id. 7.
However, the Court dismissed plaintiff’s additional allegations of alleged misstatements, noting that plaintiff admitted that the CEO did not make those statements, and further holding that there were no allegations showing that the individuals responsible for the statements acted with scienter or that the statements were “so important and so dramatically false” that scienter should be imputed to the company. Id. at 7-8. The Court also dismissed all claims against the company’s CFO, noting that plaintiff had merely alleged that the CFO “signed or authorized” SEC filings, “had the power to authorize or approve” public statements, and spoke on earnings calls and at investor conferences, which the Court held amounted to “little more than a generic job description” that “comes nowhere close” to sufficiently alleging scienter. Id. at 3.
Finally, having held that plaintiff could pursue a Section 10(b) claim against the CEO as the maker of the one statement found actionable, the Court noted that it was “duplicative and nonsensical” to impose secondary control person liability against the CEO for that same statement, and dismissed the Section 20(a) claim against the CEO on that basis.